How rates will continue to impact cash management in 2021

(Originally published in Bond Buyer February 26, 2021)

The Federal Reserve’s response to the COVID-19 pandemic has pushed interest rates to historic lows over the past year.

Changes to the Fed funds target rate and an extensive bond-buying program have driven down rates both at the short and long end of the yield curve. The 10-year Treasury, with a yield that had hovered around 1%, has led to the lowest mortgage rates in memory. A return of the Fed funds overnight rate to a target range of 0 to 25 basis points — a level not seen since the financial crisis — has caused most banks and brokerage firms to cut the rate they pay on cash to as little as 0.01%.

With the Fed targeting an inflation rate of 2%, and with Chairman Jerome Powell’s stated willingness to let inflation exceed that level for a while to make up for past misses, this effectively means that clients sitting on cash are earning a negative real return. And with the average high net worth household keeping 22.1% of its assets in cash, underearning on this asset class can lead to a material drag on overall real returns.

High net worth households keep 22.1% of their assets in cash. Most are dramatically under-earning on this asset class.

Where are we now?

Historically, financial advisors relied on money market funds to manage idle cash that remains in client portfolios. In the current rate environment, this is no longer a good option for clients. The average government MMF is yielding just 0.02%, so financial advisors who are still using MMFs as a tool for client cash may be relying on outdated advice. Similarly, most brokerage sweeps pay just 0.01%, also not an attractive option. Even the average bank savings account offers a paltry 0.04%,